“Hard times ahead” – Mervyn King

In the latest Bank of England quarterly inflation report published yesterday the governor suggested that inflation would remain well above its 2% target in two years' time if interest rates were cut to 4.5%, as markets had been expecting.

Mervyn King indicated that high inflation is here for the foreseeable future as the Consumer Prices Index (CPI) measure of inflation jumped from 2.6% to 3% in April mainly due to the rising cost of food and fuel.

Howard Archer at Global Insight said the report "makes pretty depressing reading and highlights just how difficult the Bank of England's job is at the moment as it faces an increasingly worrying mix of markedly slowing growth and well above-target and rising inflation, with still very tight credit conditions thrown in for good measure."

"The Inflation Report further dampens already rapidly dwindling hopes that interest rates will be cut in June and suggests that rates will fall no lower than 4.50%."

The warning comes in a gloomy set of forecasts which predict the CPI could rise as high as 3.7% this year and stay above 3% until well into 2009.

King said the Bank of England's monetary policy committee faced an even more "challenging" balancing act between controlling inflation and preventing an economic slowdown than it did in February. He warned of a difficult period ahead for households as inflation rises.

"The Monetary Policy Committee is facing its most difficult challenge yet," said King. "We are travelling along a bumpy road as the economy rebalances. Monetary policy cannot, and should not try to, prevent that adjustment."

"As price increases feed through to household bills, they will lead to a squeeze on real take-home pay, which will slow consumer spending and output growth, perhaps sharply," he said.

However, King played down the risk of a UK recession. "We might get the odd quarter or two of negative growth but that is not in the central projection," he said.